Massachusetts Proposes Registration Requirement for 3(c)(1) Fund Managers
As we discussed earlier in our post of state regulation of expert networks, the states are beginning to propse rules for investment advisers based on changes to the federal securities laws as a result of the Dodd-Frank Act (see California Request for Comments). The purpose of the rule changes at the state level are to create a uniform system of regulatory oversight of advisers and to avoid a form of regulatory arbitrage. That is, if the state laws remained the same after the federal laws go into effect, many smaller fund managers could remain unregistered.
Massachusetts, which has a current investment adviser registration exemption for certain hedge fund managers, is proposing to essentially eliminate any registration exemption for hedge fund managers, except for those managers to Section 3(c)(7) funds. This means that if the Massachusetts proposed regulations (reprinted below) are adopted as proposed, all Section 3(c)(1) hedge fund managers in Massachussets will need to register as investment advisers in order to continue accepting assets.
Proposed Regulations Overview
There are two main parts of the new proposed rules:
1. Change in the definition of “institutional buyer”. The current MA regulations exempt managers from the registration requirements if they only provide investment advice to “institutional buyers”. The term “institutional buyer” currently includes hedge funds with only accredited investors who contribute at least $50,000 to the fund. The new definition will essentially erase hedge funds from the definition of institutional buyer. There is a grandfathering provision for managers which currently rely on the exemption; however, those managers will not be able to accept any new investors into their funds
and they will not be able to allow existing investors to add additional subscription amounts (unless the manager subsequently registers as an investment adviser).
2. Exemption for Certain Exempt Reporting Advisers. An Exempt Reporting Adviser is a fund manager which is not registered with the SEC becasue the manager has less than $150M of AUM. For managers that are (i) exempt reporting advisers, (ii) located in Massachusetts and (iii) provide investment advice to one or more Section 3(c)(7) funds, an exemption from registration in Massachusetts is available if:
- The firm and the representatives are not subject to certain “disqualification” provisions
- The firm files the Exempt Reporting Adviser form with the commonwealth of Massachusetts (probably electronically through the IARD)
- The firm pays a fee to the Securities Division
What This Means
Essentially fund managers who are located in Massachussets will need to register with the Securities Division (unless the manager provides advice only to Section 3(c)(7) funds). Registration generally will take about two months and the firm and representatives will face certain regulatory requirements such as maintaining a bond and taking certain proficiency exams (generally the Series 65 exam).
For other state managers, this likely means that other states will follow suit and begin to propose new regulations requiring investment adviser registration.
Comment Period
The Division of Securities is accepting comments on the proposed rules prior to promulgating final regulations. Interested persons have until June 24 to file comments with the Division.
Below we have provided the Division’s stated reason for proposing these regulations (which can also be found here) and we have also printed the full proposed changes.
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Change in Exclusion/Exemption Requirements for Hedge Funds and other “Private Funds”
On July 21, 2010, Congress passed the most sweeping financial legislation enacted since the 1930s: the Dodd-Frank Consumer Protection and Regulatory Reform Act. The proposed amendments to the Massachusetts regulations referenced in this section are necessary to promote consistency between state and new federal requirements concerning investment adviser regulation, including regulation of “private funds.”
In part to address the elimination of the exemption for advisers with fewer than fifteen clients, the Securities and Exchange Commission (“SEC”) has proposed to exempt: 1) advisers solely to private funds with less than $150 million in assets under management, and 2) venture capital funds regardless of the amount of assets under management. The SEC has proposed to define a “private fund” as a fund that would be Investment Company under the Investment Company Act of 1940, but for section 3(c)(1) or 3(c)(7) of the Act. This new category of “exempt reporting” advisers must submit reports to the SEC and are subject to other regulatory requirements.
Exempt reporting advisers at the federal level will still be required to either register with the individual states in which they do business, or claim an available exclusion or exemption. The North American Securities Administrators Association (“NASAA”) has proposed a private funds model rule consistent with the new Dodd-Frank requirements.
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erline;”>12.205(1)(a)(6) – Definition of Institutional Buyer
The proposed amendment to 12.205(1)(a)(6) will phase out existing subsection (b), which defined institutional buyer as including “an investing entity whose only investors are accredited investors as defined in Rule 501(a) under the Securities Act of 1933 (17 CFR 230.501(a)) each of whom has invested a minimum of $50,000.” Following the date of implementation, investment advisers will no longer be able to rely on this exemption for new beneficial owners or additional funds for existing investors. However, advisers can continue to rely upon the exemption for business that existed prior to the implementation date.
12.205(2)(c) Exemption for Exempt Reporting Advisers
The Division proposes to remove the institutional buyer exemption located in 12.205(b), and adopt an exemption in order to ensure proper regulation of investment entities whose regulatory oversight has come within the ambit of state responsibility. In its place, the Division proposes to adopt a regulation consistent with the Dodd-Frank requirements.
The proposed addition to 12.205(2) creates a registration exemption for “exempt reporting advisers.” The proposal would exempt advisers to 3(c)(7) and venture capital funds from Massachusetts registration requirements, subject to certain limitations. These exempt advisers will file the same report and amendment thereto that an exempt reporting adviser is required to file with the SEC.
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Change in Exclusion/Exemption Requirements for Hedge Funds and other “Private Funds”
Changes to the “Institutional Buyer” Exclusion in 950 CMR 12.205(1)(a)(6)
Delete the current language of 950 CMR 12.205(1)(a)(6) and replace with the following:
6. Institutional Buyer shall include any of the following:
a. An organization described in Section 501(c)(3) of the Internal Revenue Code with a securities portfolio of more than $25 million.
b. An investing entity:
i. whose only investors are accredited investors as defined in Rule 501(a) under the Securities Act of 1933 (17 CFR 230.501(a)) each of whom has invested a minimum of $50,000; and
ii. which existed prior to [effective date]; and
iii. which, as of [effective date], ceased to accept beneficial owners or additional funds for existing investors.
c. An investing entity whose only investors are financial institutions and institutional buyers as set forth in M.G.L. c. 110A, § 401(m) and 950 CMR 12.205(1)(a)6.a. and b.
Registration Exemption for Exempt Reporting Advisers
Insert a new subsection (c) into 950 CMR 12.205(2) as follows:
(c) Registration Exemption for Exempt Reporting Advisers.
1. An investment adviser who provides advice solely to one or more 3(c)(7) funds or venture capital funds shall be exempt from the registration requirements of Section 201 of the Act if the investment adviser satisfies the following conditions:
a. Neither the investment adviser nor any of its advisory affiliates are subject to a disqualification as described in Rule 262 of SEC Regulation A, Section of title 17 CFR § 230.262.
b. The adviser files with the Commonwealth each report and amendment thereto that an exempt reporting adviser is required to file with the Securities and Exchange Commission pursuant to SEC Rule 204-4, 17 CFR 275.204-4.
c. The adviser pays the fee specified in 950 CMR 12.205(2)(b)1.b.
2. A Federal Covered Adviser shall not be eligible for this exemption and shall comply with the state notice filing requirements applicable to such advisers pursuant to 950 CMR 12.205(2)(b).
3. An investment adviser representative is exempt from the registration requirements of 950 CMR 12.205(2)(d) if registration would be required solely because of employment or association with an adviser exempt from registration under this subsection (c).
4. The report filings described in paragraph 1.b. above shall be made electronically through the IARD. A report shall be deemed filed when the report required by 950 CMR 12.205(2)(a)(1) and the fee are filed and accepted by the IARD on the state's behalf.
5. This exemption shall not be available to any investment adviser when one or more of the investment adviser's private funds accepts investments from non-natural persons for the purposes of evading registration or the conditions or limitation explicitly stated in this section.
6. Definitions:
a. “Private fund” means an issuer that would be an investment company as defined in section 3 of the Investment Company Act of 1940, 15 U.S.C. 80a-3, but for sections 3(c)(1) or 3(c)(7).
b. “3(c)(7) fund” means a private fund that is excluded from the definition of an investment company under section 3(c)(7) of the Investment Company Act of 1940, 15 U.S.C. 80a-3(c)(7).
c. “Venture capital fund” means a private fund that meets the definition of a venture capital fund in SEC Rule 203(l)-1, 17 C.F.R. § 275.203(l)-1.
Renumber the current subsection (c) of 950 CMR 12.205(2) as subsection (d) Registration of Investment Adviser Representatives.
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Cole-Frieman & Mallon LLP is a boutique hedge fund law firm which provides state and SEC investment advisor registration services for hedge funds. Bart Mallon can be reached directly at 415-868-5345.
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